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ALSK > SEC Filings for ALSK > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for ALASKA COMMUNICATIONS SYSTEMS GROUP INC

Form 10-Q for ALASKA COMMUNICATIONS SYSTEMS GROUP INC


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS AND ANALYSTS' REPORTS

This Form 10-Q and our future filings on Forms 10-K, 10-Q and 8-K and the documents incorporated therein by reference include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"), as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements. All statements other than statements of historical fact are "forward-looking statements" for purposes of federal and state securities laws, including statements about anticipated future operating and financial performance, financial position and liquidity, growth opportunities and growth rates, pricing plans, acquisition and divestiture opportunities, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, investment and expenditure plans, financing needs and availability and other similar forecasts and statements of expectation and statements of assumptions underlying any of the foregoing. Words such as "anticipates", "believes", "could", "estimates", "expects", "intends", "may", "plans", "projects", "seeks", "should" and variations of these words and similar expressions are intended to identify these forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Forward-looking statements by us are based on estimates, projections, beliefs and assumptions of management and are not guarantees of future performance. Such forward-looking statements may be contained in this Form 10-Q under "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere. Actual future performance, outcomes, and results may differ materially from those expressed in forward-looking statements made by us as a result of a number of important factors. Examples of these factors include (without limitation):

• our ability to consummate the wireless joint venture (AWN) with GCI announced on June 5, 2012, and once consummated the ability of AWN to integrate, operate, and improve the wireless assets contributed to it while maintaining effective interfaces with our retail business and generating sufficient cash flow to pay dividends to us;

• our substantial debt which requires us to dedicate a significant portion of our cash flow from operating activities to make debt payments and places pressure on our ability to access the capital markets and to fund capital opportunities;

• our ability to comply with the covenants and other terms contained in our Amended Senior Credit Facility;

• our strongly competitive environment, which comprises national and local facilities-based competitors, and the entry of one or more additional facilities-based carriers into the Alaska market; Verizon Wireless ("Verizon") is expected to enter the market in 2013;

• governmental and public policy changes, including changes in our revenues resulting from regulatory actions affecting inter-carrier compensation ("ICC") and changes in revenue from Universal Service Funds ("USFs");

• the outcome of on-going IRS audits and the ability of certain third parties to fulfill their indemnity obligations to us in the event that there is an assessment as a result of these audits;

• the cost and availability of future financing in the amounts, at the terms, and subject to the conditions necessary, to support our business and pursue growth opportunities;

• our ability to keep pace with rapid technological developments and changing standards in the telecommunications industry, including our ability to obtain new devices, spectrum, bandwidth, and other network elements;

• our ability to develop attractive, integrated products and services making use of our substantial investments in fiber optic cable facilities, including our Alaska Oregon Network ("AKORN®") and Northstar fiber optic cables that connect Alaska to the contiguous states;

• unanticipated damage to one or more of our fiber optic cables resulting from construction or digging mishaps, fishing boats or other reasons;

• changes in general industry and market conditions, and structural declines for voice and other legacy services within the telecommunications industry;

• a maintenance or other failure of our network or data centers;

• a failure of back-office information technology ("IT") systems;


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• a third party claim that the Company is infringing upon their intellectual property, resulting in significant litigation or licensing expenses, or the loss of our ability to sell or support certain products including certain smart phones;

• changes in overall national, regional or local economic conditions;

• unanticipated costs required to fund our post-retirement benefit plans;

• the success or failure of any future acquisitions;

• loss of key personnel; and

• the matters described under "Item 1A - Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and this Quarterly Report on Form 10-Q.

In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements. Additional risks that we may currently deem immaterial or that are not currently known to us could also cause the forward-looking events discussed in this Form 10-Q or our other reports not to occur as described. Except as otherwise required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this Form 10-Q.

Investors should also be aware that while we do, at various times, communicate with securities analysts, it is against our policy to disclose to them any material non-public information or other confidential information. Accordingly, investors should not assume that we agree with any statement or report issued by an analyst irrespective of the content of the statement or report. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.

OVERVIEW

We provide leading integrated communications services to consumer and business customers in and out of Alaska. Our communications networks extend throughout Alaska and connect to the contiguous states via our two diverse undersea fiber optic cable systems. These networks are among the most expansive in Alaska and form the foundation of service to our customers. Our significant wireless spectrum holdings are used in the delivery of our wireless services.

The sections that follow provide information about important aspects of our operations and investments and include discussions of our results of operations, financial condition and sources and uses of cash. In addition, we have highlighted key trends and uncertainties to the extent practicable. The content and organization of the financial and non-financial data presented in these sections are consistent with information we use in evaluating our own performance and allocating our resources. We also monitor the state of the economy in general. In doing so, we compare Alaskan economic activity with broader economic conditions. In general, we believe that the Alaskan telecommunications market, as well as general economic activity in Alaska, is affected by certain economic factors, which include:

• investment activity in the oil and gas markets;

• tourism levels;

• governmental spending and activity of military personnel;

• the price of bandwidth;

• the growth in demand for bandwidth;

• decline in demand for voice and other legacy services;

• local customer preferences;

• unemployment levels; and

• housing activity.

We have observed variances in the factors affecting the Alaskan economy as compared to the U.S. as a whole. Some factors, particularly the price of oil and gas, usually have the opposite effect on the Alaskan economy than the U.S. economy as a whole.

Prior to 2012, although the Company had been experiencing a steady decline in its retail customer base, total revenues remained relatively unchanged. This was accomplished by generating higher foreign roaming and


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wireless CETC revenue to offset lower retail revenue. In 2011, two significant events arose that will impact this overall revenue stability. The first was Verizon's anticipated entry into the Alaska market, and the second was future declines in wireless CETC and other wireline high cost support revenue as a result of changes enacted by the FCC. Foreign roaming revenue, CETC and high cost support revenues represented approximately 24% of our total revenue in 2011, and profit margins on these revenues streams are relatively high.

In part as a result of these events, management recommended a long-term plan that focused on driving growth in retail broadband services across multiple market segments, both wireline and wireless. Previously, the Company had focused on market segments that generated the highest incremental returns. This long-term plan required investment in sales, service, marketing and product development and other initiatives. At the same time, management and the Board of Directors recognized that the Company needed to reduce its outstanding debt, particularly with the entry into Alaska by Verizon Wireless.

Consequently, in the fourth quarter of 2011 our Board of Directors reduced our quarterly common stock dividend from $0.215 to $0.05 per share to pay down debt and fund our plan.

On June 5, 2012, the Company announced the AWN Transaction, allowing it to combine its wireless network with that of GCI. The AWN transaction also provides that GCI pay ACS $100.0 million at closing, and that AWN pay ACS a preferred dividend over the first four years after formation totaling up to $190.0 million. This transaction is expected to improve the Company's long-term competitive position for wireless services in Alaska while also accelerating the pay down of debt by designating $65.0 million of the $100.0 million in proceeds at closing to the payment of debt. The transaction requires numerous conditions to close, one of which was an amendment to our Senior Credit Facility. On November 1, 2012, an amendment was entered into allowing for the transfer of assets to AWN, along with a modification of certain covenants.

In order to further accelerate the delevering of our balance sheet and, in connection with our Credit Amendment, secure the continued support from our senior lenders on favorable terms, our Board of Directors elected to suspend our quarterly cash dividend beginning in the fourth quarter of 2012. See "Note 10 - Subsequent Events" in the Notes to Condensed Consolidated Financial Statements.

Regulatory Update

The items reported under Part I, Item 1: "Business - Regulation" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, are updated as follows. This section should be read in conjunction with the corresponding items previously disclosed in our Annual Report.

Federal Regulation

Interconnection with Local Telephone Companies and Access to Other Facilities

The updated global interconnection and resale agreement between our Local Exchange Carriers (ACSA, ACSAK, ACSF and ACSN) and GCI governing the provision of unbundled network elements and other services, which was signed in December 2011 and effectively extends the original March 15, 2007 global interconnection agreement between our Company and GCI (with certain modified terms and conditions), was approved by the Regulatory Commission of Alaska ("RCA") on March 8, 2012, and is currently in effect for a term of five years.

Lifeline Reform

In conjunction with the FCC's January 2012 Lifeline Order, the FCC continues to evaluate further changes to its Lifeline program in an ongoing Further Notice of Proposed Rulemaking ("FNPRM"). There are a number of matters under consideration that could increase the Company's regulatory compliance obligations and customer administrative responsibilities, and impact revenue received from regulatory funding sources. We expect a state or national eligibility database requirement could involve costs to establish the database and to access the database. In addition, in its Lifeline Order, the FCC reduced the Lifeline discount amount reimbursed to Lifeline service providers on an interim basis, and in the FNPRM it is considering whether to revise that discount amount, which could result in a permanent reduction of federal Lifeline subsidy support.

AWN

In connection with the formation of AWN:

• The Company is seeking a declaratory ruling from the FCC that access by the Company to AWN's facilities and services constitutes "access to spectrum" in areas in which the Company holds Licenses for the purpose of 47 C.F.R. §54.1003(b), and any similar provisions with respect to Mobility Fund Phase II;


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• The Company is seeking an order from the Securities and Exchange commission that either (i) after the formation of AWN, the Company will be primarily engaged in a business other than that of investing, reinvesting, owning, holding or trading in securities, or, alternatively, (ii) pursuant to Section 6(c) of the Investment Company Act, will be exempted from the Investment Company Act; and

• GCI made the required filing under the Hart-Scott-Rodino Act (the "HSR Act"), but prior to the expiration of the HSR waiting period; the Company received a civil investigation demand from the U.S. Department of Justice to which the Company is responding.

Universal Service

In the October 2011 USF/ICC Order, the FCC voted unanimously to overhaul portions of its USF and ICC systems. Among other changes, the FCC created the Connect America Fund ("CAF"), which is intended to supplant existing high cost universal service support mechanisms and require recipients of universal service support to deploy broadband Internet access service as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. The FCC adopted a phased implementation schedule for the CAF. We are currently in Phase One of this implementation.

In adopting the USF/ICC Order, the Commission announced its intent to adopt a predictive cost model to govern the distribution of CAF Phase Two support by December 31, 2012. We now consider it unlikely that the FCC will adopt a cost model before December 31, 2012. If the FCC does not adopt a cost model, we will continue to receive high cost support under CAF Phase One, which will provide us with high cost support at frozen levels prevailing under Phase One.

In April 2012, the FCC announced offers of additional CAF Phase One Incremental Support. Price Cap local exchange carriers accepting these offers of support are required to deploy broadband Internet access service to one unserved location for every $775.00 of this support that they accept. On July 24, 2012, we accepted the FCC's offer of $4.2 million of CAF Phase One Incremental Support. However, on September 26, 2012, we filed a Petition for Waiver with the FCC seeking additional flexibility in using this support, including the ability to use the support to deploy broadband to fewer unserved locations than the FCC's rules require, to deploy broadband to locations served only by wireless Internet access service providers, or to improve broadband services in areas where we are the only provider of such services.

Rate Regulation

On August 22, 2012, the FCC released an Order suspending the process by which incumbent local exchange carriers may obtain new grants of pricing flexibility for special access transport services. The Order did not alter or withdraw any existing grants of pricing flexibility, including those we hold. The Order lays out a process for initiating a broad data-gathering effort through which the FCC intends to analyze the operation of special access markets. The FCC stated its intent to analyze the data and establish a new framework for pricing flexibility in 2013. We anticipate that the future framework, when adopted, could involve changes to our existing grants of pricing flexibility, and require more rigorous showings when seeking new grants of pricing flexibility.

State Regulation

Other RCA Proceedings

On April 19, 2012, the RCA opened a docket to consider whether to modify the current $3.50 level of Lifeline support payments made to eligible telecommunications carriers by the Alaska Universal Service Administrative Company and has invited comments from interested parties. Based on the input it receives, the RCA may decide subsequently to open one or more rule-making proceedings proposing to increase, decrease or eliminate such Lifeline support payments. Depending on the ultimate outcome, there could be a revenue impact to the Company, but it is not possible to determine the amount or whether it might be favorable or unfavorable to us.

2012 Focus

Our results of operations, financial position and sources and uses of cash in the current and future periods reflect our focus on being the most successful broadband solutions company in Alaska by delivering the best customer experience in the markets we choose to serve. To do this we will continue to:

• Develop Our Workforce to Build Our Sales and Service Capabilities. We believe an engaged workforce is critical to our success.

• Provide a Delightful Customer Experience Every Time. We believe the economics of retaining a customer always prevails over those of adding a customer. We invest in training, process and systems improvements to continuously improve the customer experience we create.

• Simplify How We Do Business. We believe we must reduce waste in non-value-added activities. We are accelerating our investments in technology and process improvement and expect these efforts to meaningfully impact margins in the next two to three years.

• Offer Broadband Solutions to Our Customers at Home, at Work and Everywhere in Between. We are building on strength in designing, building and operating quality networks and provide new products and solutions to our customers.

We believe we can create value for our shareholders by carefully investing cash flows generated by the business in specific opportunities and transactions that support these imperatives, and by delevering our balance sheet. To further support the pay down of debt and secure the continued support from our senior lenders on favorable terms, our Board of Directors elected to suspend our current cash dividend. See "Note 10 - Subsequent Events" in the Notes to Condensed Consolidated Financial Statements.

During the remainder of 2012 we will continue to focus on consummation of the AWN Transaction, including obtaining the required regulatory approvals and meeting the other conditions detailed in the Asset Purchase and Contribution Agreement. As described below, an amendment extending our Collective Bargaining Agreement with the IBEW was ratified on October 4, 2012, and on November 1, 2012, we reached an agreement with our lenders to amend our Senior Credit Facility. We believe that consummation of these transactions and the subsequent successful performance of AWN will benefit our future cash flows and create value for our shareholders. We currently expect that the AWN Transaction will close no later than the second quarter of 2013.

Revenue Sources by Customer Group

We manage our revenues based on the sale of services and products to the following major customer groups:

• Business and Wholesale: We provide communications services including local and long distance voice, broadband data, Internet access, network access, data hosting, billing and collection services, IT management and cloud-based services, to carriers, business and government customers.


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• Consumer: We provide local and long distance voice, broadband data, Internet access and other communications products and services to residential customers.

• Wireless: We provide wireless facilities-based voice and data services, products, other value-added services and equipment sales statewide across Alaska with roaming coverage available in the contiguous states, Hawaii and Canada.

• Access and CETC: We provide voice and broadband termination services to inter and intrastate carriers who provide services to our retail customers. We also receive interstate high cost support funds and other revenue streams as structured by state and Federal regulatory agencies.


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The table below provides certain key operating metrics as of or for the periods indicated. ARPU is defined as average monthly revenue per user.

                                                         September 30,
                                                      2012           2011

        Voice:
        At quarter end:
        Consumer access lines                          57,483         63,775
        Business access lines                          81,330         84,185
        Quarter:
        ARPU - consumer                             $   26.65      $   26.70
        ARPU - business                             $   24.34      $   25.39
        Year-to-date:
        ARPU - consumer                             $   26.68      $   26.96
        ARPU - business                             $   24.39      $   25.51

        Broadband:
        At quarter end:
        Consumer connections                           38,491         39,602
        Business connections                           19,063         19,051
        Quarter:
        ARPU - consumer                             $   39.90      $   35.52
        ARPU - business                             $  150.58      $  140.77
        Year-to-date:
        ARPU - consumer                             $   38.81      $   34.85
        ARPU - business                             $  146.44      $  133.93

        Wholesale lines at quarter end                 20,782         23,749

        Wireless:
        At quarter end:
        Postpaid connections                          107,220        108,664
        Prepaid connections                            13,755          8,832

        Total                                         120,975        117,496

        Quarter:
        ARPU - retail                               $   51.79      $   52.81
        ARPU - broadband                            $   19.70      $   16.82
        Year-to-date:
        ARPU - retail                               $   51.58      $   52.64
        ARPU - broadband                            $   18.59      $   15.65

        Churn:
        Voice access lines                                1.4 %          1.7 %
        Broadband connections                             2.2 %          2.3 %
        Wireless connections                              2.0 %          2.4 %

        Wireless equipment subsidy (in thousands)
        Quarter                                     $   2,608      $   2,731
        Year-to-date                                $  11,725      $   9,680


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RESULTS OF OPERATIONS

All amounts are discussed at the consolidated level after the elimination of affiliate revenue and expense.

Three Months Ended September 30, 2012 Compared to Three Months Ended
September 30, 2011



                                                  Three Months ended September 30,
 (in thousands)                           2012           2011         Change       % Change
 Operating revenues:

 Business and wholesale
 Retail service revenue
 Voice                                  $   5,967      $  6,440      $   (473 )         -7.3 %
 Broadband                                  8,613         8,046           567            7.0 %
 Equipment sales                              311           224            87           38.8 %
 Wholesale and other                       11,587        10,597           990            9.3 %

 Total business and wholesale revenue      26,478        25,307         1,171            4.6 %


 Consumer
 Retail service revenue
 Voice                                      4,676         5,173          (497 )         -9.6 %
 Broadband                                  4,613         4,266           347            8.1 %
 Equipment sales                               42            48            (6 )        -12.5 %
 Other                                        413           268           145           54.1 %

 Total consumer revenue                     9,744         9,755           (11 )         -0.1 %


 Wireless
 Retail service revenue
 Voice                                     12,355        12,973          (618 )         -4.8 %
 Broadband                                  6,340         5,490           850           15.5 %
 Equipment sales                            1,737         1,541           196           12.7 %
 Foreign roaming                           18,919        13,525         5,394           39.9 %
 Other                                      1,132         1,223           (91 )         -7.4 %

 Total wireless revenue                    40,483        34,752         5,731           16.5 %


 Access and CETC
 CETC                                       4,979         6,022        (1,043 )        -17.3 %
 High cost support                          5,087         4,480           607           13.5 %
 Switched, special and other access        10,024         9,990            34            0.3 %

 Total access and CETC                     20,090        20,492          (402 )         -2.0 %


 Total operating revenues                  96,795        90,306         6,489            7.2 %


 Operating expenses:
 Cost of services and sales                36,346        34,505         1,841            5.3 %
 Selling, general and administrative       25,437        24,121         1,316            5.5 %
 Depreciation and amortization             12,932        14,392        (1,460 )        -10.1 %
 Gain on disposal of assets, net           (2,559 )        (709 )      (1,850 )        260.9 %

 Total operating expenses                  72,156        72,309          (153 )         -0.2 %


 Operating income                          24,639        17,997         6,642           36.9 %

 Other income and expense:
 Interest expense                         (10,268 )      (9,529 )        (739 )          7.8 %
 Interest income                                9            10            (1 )        -10.0 %
 Other                                         -            174          (174 )       -100.0 %

 Total other income and expense           (10,259 )      (9,345 )        (914 )          9.8 %


 Income before income tax expense          14,380         8,652         5,728           66.2 %

 Income tax expense                        (6,136 )      (9,468 )       3,332          -35.2 %


 Net income (loss)                      $   8,244      $   (816 )    $  9,060             n/ a
. . .
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